Subprime lending explodes

SALT LAKE CITY—Wayne Thompson has been considering tapping into the subprime lending market for about two years. The idea is in his business plan for Lexington, Ky.-based Residential Mortgage Services, but other changes have taken priority.

Still, it made sense that Thompson attended a session at the 2004 National Association of Mortgage Brokers convention here on subprime lending. He didn’t learn a lot of about the nuts and bolts of setting up that type of business, but he came away with a newfound appreciation for the increase in subprime lending over the last few years.

"It just blew my mind," he said.

Subprime mortgage originations totaled $322.9 billion in 2003, an almost eight-fold increase over the $41 billion originated in 1996. Moreover, subprime originations grew in all the years in between, even in 1999 and 2000 when interest rates rose, making that market a potentially lucrative one as interest rates continue their climb now.

Stuart Feldstein, president of SMR Research Corp. , led a discussion on "The non-prime industry is expanding: Are you prepared to take advantage?" In addition to talking about the potential opportunities for mortgage brokers interested in the subprime market , Feldstein also pointed out possible pitfalls, including various legal requirements.

The idea, he told attendees, was to give them both sides of the issue so they could decide for themselves: "Is this really such a great opportunity or is it something to avoid?"

On the opportunity side of the argument lie the sheer numbers, as evidenced by the dramatic increase in volume.

Subprime mortgage accounted for about 10 percent of all mortgages in 2003, and Feldstein expects that figure to increase to about 12 percent this year.

That’s still a small portion of the overall mortgage origination total, but the number of subprime borrowers keeps growing, he said.

Several factors are contributing to that increase, including a growing gap between the rich and poor. As the middle class continues to shrink, Feldstein said, the numbers of both super-prime and subprime borrowers have increased.

Additionally, he said, the number of subprime borrowers has increased as more companies have issued credit cards to them. That has strained some consumers’ credit scores even further, putting them into the subprime category.

And with lenders offering easier underwriting and lower down payments, more subprime borrowers than in the past have been able to buy homes. If they want to refinance later, they often must tap the subprime market again to do so, Feldstein said.

Those factors add up to a class of borrowers that promises to grow even more, he said. That in turn creates opportunities for mortgage brokers willing to take on the sticky issues that often accompany subprime originations.

Chief among the downsides are the numerous and varying state and local "predatory" lending regulations with which subprime originators must comply. Some consumer activist groups also have lumped subprime loans with predatory loans, potentially causing public relations problems for subprime lenders and brokers, Feldstein said.

Feldstein said some activist groups have contended that subprime lenders target minorities, but the data show otherwise. For example, Hispanic and African American borrowers accounted for 14.6 percent and 13.2 percent of all subprime loans made in 2002. Those numbers reflect those groups’ percentage of the overall U.S. population – 13.7 percent for Hispanics and 11.9 percent for African Americans.

"We view that finding as proof most subprime lenders are not targeting minorities," Feldstein said.

Another downside for mortgage brokers is that subprime applicants are denied loans or withdraw or fail to finish their applications more often than prime borrowers. He said that often can be seen after brokers take a borrower’s application, then ask for all the proper documentation.

"(The prospect) says okay, leaves the office and never comes back," which leaves the broker frustrated and unable to close the loan, Feldstein said.

Feldstein also said the old methods of advertising to subprime borrowers, such as mailing or calling the general homeowner population and buying credit bureau lists of homeowners with low FICO scores, are expensive and not very effective.

Instead, he suggested brokers advertise to attract potential subprime borrowers by getting lists of homeowners who have been approved in the past by a subprime lender.

Overall, he said, subprime borrowing has its pitfalls, but it also carries expanding possibilities even as interest rates rise, Feldstein said.

"We have here an exciting and fast-growing business," he said.

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